THE NEW THREAT TO INTERNATIONAL COMMERCIAL TRANSACTIONS: CROSS-BORDER INSOLVENCY AND ITS IMPACT ON THE STANDBY LETTER OF CREDIT REGIME

By Roland Lechner

Lurking in all transnational bankruptcies is the potential for chaos if the court involved ignores the importance of comity. As anyone who has made even a brief excursion into this area of insolvency practice will report, there is little to guide practitioners or the judiciary in dealing with the unique problems posed by such bankruptcies. Yet it is critical to harmonise the proceedings in the different courts lest decrees at war with one another result.

- Judge Tina L. Brozman[1]

I. INTRODUCTION

The main purpose of the letter of credit regime is to facilitate the purchase and sale of goods by providing assurance to the seller [beneficiary of LC] of prompt payment upon compliance with the conditions in the document without the sellers having to rely on the solvency of the buyer [applicant of LC].[2] In the case of a standby letter of credit, the letter of credit obligates the issuing bank to honor the credit upon evidence of the beneficiary’s performance and upon evidence or mere declaration of the applicant’s default in the underlying contract.[3] The insolvency of the applicant, especially if it is a multinational company, or the issuing bank in this tripartite relationship[4] has potentially dire consequences and the creditor of the bankrupt party might face the possibility of partial or complete loss of its claim.

The uncertainty inherent to the insolvency of multinational companies and credit institutions is due to the fact that the international community has so far failed to draft binding legislation for a uniform procedure dealing with this occurrence. In the aftermath of the disastrous consequences of the Herstatt[5] and BCCI[6] cross-border insolvencies on the global economy, several efforts have been made to provide for effective guidelines to coordinate multinational defaults. The most promising of these efforts to date on a global level culminated in the UNCITRAL Model Law on Cross-Border Insolvency.[7] However, Model Laws are not binding per se, and each jurisdiction is vested with discretion as to what extent it will incorporate the provisions of the Model Law into its respective national bankruptcy laws.[8]

Domestic insolvency laws are often deeply rooted in each country’s societal values and public policies, which explains why the most effective agreements regarding cross-border insolvencies have been accomplished through bilateral treaties and regional conventions.[9] A good example of such a regional agreement is the European Council Regulation on Insolvency Proceedings[10] (EC Regulation) which entered into force on May 29, 2002 and provides a comprehensive set of conflict-of-law rules for cross-border insolvencies within the Member States of the European Union (EU). Although the EC Regulation is merely regional in scope and does not apply to business entities outside the EU jurisdictions, it nevertheless constitutes a valuable guideline for a similar legislation with global application.

In the absence of an international regime on cross-border insolvency, the bankruptcy of multinational companies is likely to involve separate insolvency proceedings in each of the countries in which the insolvent company had subsidiaries, offices or assets. Since domestic insolvency laws vary significantly, such multiple proceedings can lead to conflicting and incompatible results and could severely impair the proper reorganization or liquidation of the insolvent company. Additionally, without a uniform framework providing binding conflict-of-law rules, the uncertainty as to which country’s law is applicable to each insolvency proceeding would defeat the purpose of the letter of credit regime which is designed to provide the parties to a letter of credit transaction with the guarantee that the obligations arising from the underlying contract will be honored.

The jurisdictional aspects involved in the default of a multinational bank are even more complex as in the case of a multinational corporation because all the above-mentioned international and regional agreements on cross-border insolvencies exclude credit institutions from their scope and application.[11] The reason for this special treatment of financial institutions can be explained by the complexity of the matter of bank insolvencies and by the divergent interests and overlapping national competencies involved.[12] Eva Hüpkes, the Head of Regulation in the Legal Department of the Swiss Federal Bank Commission, points out that “devising a legal framework for bank insolvency is already complicated on a national level, with the various authorities involved – regulatory, supervisory, and judicial – the complexity is even greater in an international context.[13] The interest of the competent national authorities to exclusively determine the course of insolvency proceedings involving financial institutions within their jurisdictions stems largely from the systemic implications for the national economies and banking systems that these proceedings will entail.[14]

This Note will focus on the insolvencies of multinational banks issuing standby letters of credit as well as the insolvencies of multinational companies applying for standby letters of credit and the respective implications of their defaults on the letter of credit regime. Part II discusses the applicable sources of jurisdictions and general principles pertaining to cross-border insolvencies. Part III analyzes the implications of conflicts of laws on the recourse available to an issuing bank of a standby letter of credit against the insolvent company that applied for the LC. Part IV discusses the recourse that the beneficiary of a LC will be able to seek against an issuing bank which became insolvent before honoring the letter of credit. Part IV will then conclude with suggestions of how the international community can deal more effectively with cross-border insolvencies in the context of letter of credit transactions.

II. JURISDICTIONAL ASPECTS AND GENERAL PRINCIPLES OF INTERNATIONAL INSOLVENCY

The most immediate task following the default of a multinational credit institution is to determine which country actually has jurisdiction over the insolvency proceeding.[15] There are four different sources of jurisdiction: the law of the creditor’s country of residence (lex domicilii), the law of the debtor’s country of residence (lex domicilii), the law of the country where the transaction occurred (lex loci contractus), and the law of the country with subject-matter jurisdiction over the assets (lex situs).[16] The possibility also exists that a fifth source of jurisdiction comes into play, which would grant jurisdiction to the country where the insolvency proceeding were opened (lex concursus).[17] However, the country with jurisdiction in accordance with lex concursus is very likely to have jurisdiction under any of the other four sources of jurisdiction.[18]

The choice of forum and the choice of law are intertwined in the area of international insolvency because no court will conduct bankruptcy proceedings pursuant to the laws of another jurisdiction.[19] Whether a jurisdiction follows a particular principle will determine if a cross-border insolvency should be administered in a single forum or multiple fora. Thus, the principles of international insolvency are not only outcome-determinate as to forum-selection, but they are also outcome-determinative regarding the selection of applicable. There are three main principles applicable to cross-border insolvencies: the territoriality principle, the universality principle, and the principle of modified universalism.

The territoriality principle does not recognize the extraterritorial effect of a foreign court’s judgment,[20] but rather it advocates that the “law of any country is applicable only to assets or persons physically subject to that [country’s] law.”[21] The underlying purpose contemplated by the principle is that the seizure of the debtor’s assets located within the borders of a country benefits domestic creditors regardless of whether a parallel foreign proceeding exists.[22] The territoriality approach is often referred to as the “grab rule”[23] because the local court takes the assets located in its geographic jurisdiction and distributes them only to those creditors who come to the court to present their claims.[24] There are several disadvantages to the territorial approach. First, foreign creditors are not treated as fairly as local creditors because in most cases they are being given late notice of the initiation of insolvency proceedings abroad. Foreign creditors also often have difficulty informing the foreign court of the existence of their claims.[25] Second, the territoriality principle might lead to inconsistent and sometimes inequitable result for creditors of the same estate because different jurisdictions have different avoidance and priority rules.[26] Thirdly, a debtor may elect to transfer local assets to another jurisdiction to favor creditors located there. Considering the difficulties inherent to a local creditor’s entrance into a foreign jurisdiction to protect his interests, such preferential transfers might prevent the local creditor from receiving any share of the debtor’s assets.[27] Finally, each jurisdiction under the territorial approach will seek the best possible outcome for local creditors, and this inevitably creates a conflict of interest with the claims of foreign creditors.[28]

Under the universality principle, a single forum administers all the debtor’s assets and makes distributions to creditors, wherever they are located and in accordance with the forum state’s substantive bankruptcy laws.[29] The single forum is typically the court with principal jurisdiction over the debtor and may be the country in which the company is incorporated, the country in which the company is headquartered, or the country in which the company has the bulk of its operations or assets.[30] All other jurisdictions are obligated to assist the court with principal jurisdiction and to recognize and enforce its orders.[31] Contrary to the territoriality principle, the universality approach distinguishes between the main insolvency proceedings and secondary insolvency proceedings.[32] These ancillary proceedings or local proceedings are auxiliary in nature and designed to assist the main proceeding in administering the assets, i.e. by turning over local assets to the main proceeding.[33]

The advantage of the universality principle is that all assets are administered and distributed by a single forum, thereby preventing unequal treatment of similarly situated classes of creditors (par conditio creditorium) and reducing the strategic importance of preferential transfers across borders.[34] However, the universality principle also has several flaws. First, the country with jurisdiction over the main proceeding will not be able to ensure the enforcement of its orders abroad by unilaterally embracing the universality principle.[35] A foreign court’s order will only enjoy full effect abroad if the other jurisdictions also recognize the principle.[36] Second, problems always arise when foreign law dictates the resolution of domestic affairs, such as the distribution of local assets, unless the substantive laws of the jurisdictions involved are largely identical.[37]

While both the universality and the territoriality principle have almost never been unequivocally implemented in their pure form,[38] many domestic courts have consistently applied the principle of modified universalism in cross-border insolvencies.[39] Under modified universalism, the forum hosting the primary proceeding, while seeking to achieve the broadest extraterritorial effect possible of its orders, leaves open the possibility of cooperation with secondary proceedings commenced in another jurisdiction.[40] In other words, the court with jurisdiction over the main proceeding will seek the assistance of the jurisdiction where the debtor’s assets are located, sometimes insisting that its own substantive insolvency rules should be applied in the foreign proceeding.[41] Contrary to pure universalism, the modified form makes cooperation between the primary and secondary proceedings discretionary. Therefore, courts with jurisdiction over secondary or territorial proceedings can better ensure that local creditors will not be unfairly treated under foreign insolvency laws and proceedings.[42]

III. THE IMPLICATIONS OF CROSS-BORDER INSOLVENCIES ON AN ISSUING BANK’S CLAIMS AGAINST THE INSOLVENT APPLICANT OF A LETTER OF CREDIT

The following scenario is the basis for the discussion in this section: On July 9, 2002, the German steel company Metallwaren AG enters into a contract with the French car manufacturer Encore which provides for the sale of hot-rolled steel. Subsequent to the execution of the contract, Encore requested the local branch of Global Bank in Nice to issue a standby letter of credit with the German company as beneficiary. After Encore provided the Global Bank with a security interest in its inventory located at manufacturing plant in Manchester sufficient to cover the letter of credit, the bank issues the letter of credit to the German company on July 15, 2002. Metallwaren AG delivered the steel timely on August 21, 2002. Encore defaulted on its payments as required by the contract on September 18, 2002. Metallwaren AG granted Encore seven days in which to cure the default, but to no avail. On October 7, 2002, Encore declared that it is unable to pay its debts (cessation des paiements). On October 10, Metallwaren AG demanded that the bank honor the letter of credit and Global Bank paid Metallwaren AG the entire sum of €150,000 as provided in the document. Encore is incorporated in France, is headquartered in Paris, maintains manufacturing plants in Manchester, England and Modena, Italy, and has administrative offices in Frankfurt and Vienna. Most of Encore’s business is being channeled through their German office in Frankfurt. Furthermore, Encore has assets in the United States and the Netherlands. The letter of credit was issued in Nice and the contract between Metallwaren AG and Encore was signed in Frankfurt.

Since May 29, 2002, the EC Regulation is applicable to the scenario described above. The EC Regulation is not designed to create a uniform set of substantive insolvency laws among the Member States.[43] Rather, it is designed to introduce common conflict-of-law rules that provide certainty to multinational business entities, which have their “centre of main interest” within the EU, regarding the applicable law in insolvency proceedings.[44] Further, every creditor, who has his habitual residence, domicile, or registered office in any of the Member States, will have the right to lodge claims in all insolvency proceedings relating to the debtor’s assets.[45] The provisions in the regulation pertaining to the determination of which Member States’ courts will have jurisdiction over an insolvency proceeding combine elements of both the territoriality and universality principle.[46]

The EC Regulation provides for two types of insolvency proceedings, namely main proceedings with universal scope and secondary proceedings with a territorial scope.[47] The courts of the Member State where the debtor has its “centre of main interest” will have jurisdiction to open the main proceeding.[48] The main proceeding will have universal effect, regarding any assets of the debtor, no matter where they are located, with the exception of assets located in a jurisdiction where a secondary insolvency proceeding has been opened.[49] The applicable law, throughout the EU for main insolvency proceedings, will be the law of the Member State where such main proceedings commence and will cover such aspects as set-off, powers of liquidators, or the distribution of assets.[50] Considering the wide applicability of the law of the Member State with jurisdiction over the main proceedings, the determination of where the main proceeding will commence is the crucial stage during the insolvency process of a multinational company.

Although the regulation does not contain a provision defining “centre of main interest”, the regulation provides that there is a rebuttable presumption that the registered office constitutes the centre of main interest.[51] A showing that the debtor conducts the administration of his interests on a regular basis in another Member State and this administration is ascertainable by third parties can defeat this presumption.[52] A recent decision issued by a British court already addressed the meaning of “centre of main interest”. In Re Enron Directo, SA, the court stated that the presumption that the main proceedings should be where the company’s registered office is located was rebutted on evidence that the management decisions of the company were taken at a different office.[53] Determining the “centre of main interest” might prove to be particularly difficult in the case of unincorporated associations because, very often, there will be no statutory seat and a center of main interests is either changing or not easily determinable.[54] Ultimately, the European Court of Justice will probably be approached to provide a specific definition of “centre of main interest”.[55]

Courts in Member States will have jurisdiction over secondary proceedings if the debtor has an “establishment” in that Member State and this jurisdiction can only be exercised over the debtor’s assets situated in the territory of that state.[56] “Establishment” is defined to mean “any place of operations where the debtor carries out a non-transitory economic activity with human means and goods.”[57] Consequently, the mere presence of assets by the debtor would not provide the courts of a Member State with jurisdiction to open secondary proceedings. The distribution of these assets would be governed by the laws of the Member State with jurisdiction over the main proceeding. Regardless of the type of the main proceeding, the secondary proceeding may only take the form of a winding-up proceeding.[58] Once the main insolvency proceeding commences, the courts opening secondary proceeding are not required to re-examine question of the debtor’s solvency.[59] It is important to note that the term “establishment” does not include the debtor’s autonomous subsidiaries in other Member States. The insolvency proceedings regarding these subsidiaries remain to be governed by the law of the Member State in which they have been incorporated.[60]

Under the present hypothetical, Encore will be presumed to have its centre of main interest in France because it is registered in France and is headquartered in Paris. However, creditors in Germany might be able to overcome this presumption by showing that most of Encore’s management decisions were conducted at the office in Frankfurt. Depending on whether French or German insolvency law will be determined to govern the main proceeding is of utmost importance, especially regarding the treatment of preferential transfers. Under French law, any transfer made between the date the debtor was effectively unable to pay its debts (cessation de paiements) and the date of the judgment initiating the insolvency proceeding[61] is subject to cancellation if certain conditions are met.[62] Additionally, a French court may declare null and void any transfer made during the six-month period prior to the “suspicious period” if the transfer was detrimental to the creditors’ debtors and the benefiting creditor was aware of the debtor’s situation.[63] Conversely, under German insolvency law a transfer that enabled a creditor to obtain satisfaction or a security interest is voidable if the transfer occurred within the three-month period before the filing of the petition for insolvency, the debtor was illiquid, and the creditor knew of such illiquidity.[64] Therefore, the determination of applicable law will significantly influence assets available for distribution among the creditors during the insolvency proceeding. For the purpose of the following discussion, this Note will assume that the French court will have jurisdiction over the main proceeding.

According to the provisions of the EC Regulation, Encore faces a main proceeding in France and the possibility of secondary insolvency proceedings in Germany, England, Austria, and Italy. In attempting to collect the amount paid under the standby letter of credit, Global Bank has to decide in which insolvency proceedings it wishes to participate. The advantage of pursuing insolvency litigation in France is that the judgment of the French court will not only be enforced against Encore’s assets located in France but also those located in the Netherlands. The case of the assets in the United States is different because the provisions of the EC Regulation are not applicable to them and the creditors must attempt to enforce the French judgment in accordance with relevant provision of the United States Bankruptcy Code.

If Global Bank elects to open a bankruptcy proceeding in France, it can file a request as soon as Encore declared that it is unable to pay its debts.[65] This request commences the so-called “observation period” (periode d’observation) during which the French court will initiate the bankruptcy proceeding and determine whether liquidation or reorganization is the appropriate measure for the insolvency proceeding.[66] When the reorganization measure seems impossible or inappropriate to the debtor’s business, then the French court may directly initiate a liquidation proceeding without an observation.[67] Instead of requesting a main proceeding in France, Global Bank has furthermore the choice of requesting secondary proceedings in Germany,[68] Austria,[69] England[70] or Italy[71] at any time after the main proceeding has commenced.

Additionally, under the EC Regulation, Global Bank can request the opening of a secondary proceeding in a Member State before the opening of a main proceeding if Global Bank has a registered office in that Member State where the claim arises from the operation of the debtor’s establishment.[72] However, since the standby by letter of credit transaction was conducted in France, this special provision is not applicable to the present case. The only other avenue to open a secondary proceeding before the commencement of the main proceeding is for Global Bank to show that the main insolvency proceeding cannot be opened because of conditions laid down by local law in the Member State where the debtor’s centre of main interest is situated.[73] Even in the unlikely case that Global Bank could satisfactorily make such showing, the “primary secondary” insolvency proceeding will be subordinated to the main insolvency proceeding one such proceedings are commenced.[74] If Global Bank chooses to participate in already opened main or secondary proceedings, it is pertinent that it lodges its claims within the time period provided for by local insolvency laws.

The EC Regulation provides significant relief to cross-border insolvencies involving businesses in EU Member States because it provides binding rules regarding coordination of multiple proceedings and regarding the recognition of foreign judgments. It therefore removes the need to look to local insolvency laws regarding the treatment of cross-border insolvencies. The orders opening main and secondary insolvency proceedings as well as the judgments issued in these proceedings are automatically recognized in all other Member States.[75] Therefore, the effect of the initiation of the insolvency proceedings in other Member States will be the same as prescribed under the laws of the Member State where the insolvency proceeding commenced. The decision of the court conducting the main proceeding can only be challenged on two grounds: 1) if the decision is contrary to the public policy of the recognized state; or 2) if a secondary proceeding has commenced in the recognizing state.[76] A challenge on public policy grounds is very difficult to sustain and usually requires the creditor to show that fundamental principles of constitutional rights, such as the right to a fair trial, have been violated.[77]

In other words, after the decision by the French court to initiate a liquidation proceeding against Encore, Encore no longer has the ability to dispose of or manage its assets located within the EU until the proceeding is closed.[78] Furthermore, once the main insolvency proceeding has commenced, Global Bank has the certainty that creditors located in other Member States will not be able to attach Encore’s assets situated in that jurisdiction. This moratorium or stay order will have immediate effect with respect all assets of Encore, except those assets located in Member States where secondary proceedings have been commenced. Therefore, the French order will cover assets located in France and the Netherlands, but not assets located in England, Austria, Germany, or Italy. Orders and judgments rendered in secondary proceedings will receive automatic recognition with regard to the assets located in the respective jurisdiction where such a proceeding commenced but have no effect on extraterritorial assets, with the exception of assets removed from the jurisdiction after the proceeding commenced.

The liquidators appointed in the main and secondary proceedings are vested with considerable powers in order to collect and safeguard assets. Particularly, the liquidator in the main proceeding is empowered to exercise “all the powers conferred on him by the law of the State of the opening of proceedings in another Member State, as long as no other insolvency proceedings have been opened there nor any preservation measure to the contrary has been taken there.”[79] These powers allow the liquidator in the main insolvency proceeding to remove the debtor’s assets over which it has jurisdiction from the territory of the Member State in which they are situated.[80] Liquidators in the secondary proceeding(s) may, either through the courts or out of courts, claim moveable property which was removed from its jurisdiction after the secondary proceeding was opened.[81] In claiming or removing assets from another jurisdiction, the liquidators have to comply with the laws of the Member State in which they intend to take action, especially regarding the procedure for the realization of assets.[82]

The EC Regulation also provides extensive guidelines regarding the extent to which the liquidators are able to participate in each other’s proceedings. The liquidator of the main proceeding has considerable powers to participate in the secondary proceeding: First, during the course of the secondary insolvency proceeding, he has the obligation to lodge claims that have already been filed in the main proceeding.[83] Second, if a secondary proceeding has been established, the liquidator of the main proceeding is entitled under Article 33(1) to request a stay of the liquidation process in the secondary insolvency proceeding if the continued liquidation would be contrary to the interests of the creditors in the main proceeding.[84] The liquidator must also consent to the closure of a secondary insolvency proceeding.[85] Finally, in the unlikely event of a surplus after the liquidation of assets and satisfaction of the claims allowed in the secondary proceeding, these remaining assets must be transferred immediately to the debtor’s estate in the main insolvency proceeding.[86]

The French liquidator (liquidateur) and the liquidators appointed in secondary insolvency proceedings have the power to avoid preferential transfers or other legal acts detrimental to all creditors which were conducted in violation of their respective national insolvency laws. The powers of the French liquidator are furthermore enhanced by allowing him to collect assets in other Member State in which Encore does not have an establishment, i.e. the Netherlands. The liquidators in the German, Austrian, British, or Italian proceedings are only able to exercise these powers, i.e. the removal of assets out of another jurisdiction, only with respect to local assets. The enhanced powers of the liquidator in the main proceeding reinforce the importance for a creditor to be able to participate in this main proceeding because this proceeding is very likely to cover and distribute the biggest part of the debtor’s assets.

The effectiveness of the liquidator in the main proceeding depends also largely on the cooperation he receives from the liquidators appointed in the secondary proceeding. After the main proceeding is opened, all of the debtor’s assets located in a EU Member State will attach to the estate in the main proceeding. However, as soon as a secondary proceeding commences, the estate available to the main proceeding will be reduced by the assets located in the Member State where the secondary proceedings occur.[87] As already noted above, the liquidator in the main proceeding can participate quite actively in the secondary proceedings, i.e. by lodging claims and even ordering a stay of the proceeding, in order to protect the “main estate”, such participation will have no effect unless the other liquidators comply with his orders. Although the EC Regulation provides that the liquidators in the main proceeding and the secondary proceedings are duty bound to communicate information to and cooperate with each other,[88] the implementation of these provisions cannot be monitored by courts because the competent insolvency court is only empowered to supervise the compliance of the proceedings with domestic insolvency laws.[89]

The EC Regulation contains two other provisions which potentially are of importance to Global Bank’s assessment of its recourse against Encore. Article 6 of the regulation states that “the opening of insolvency proceedings shall not affect the right of creditors to demand the set-off of their claims against the claims of the debtor, where such a set-off is permitted by the law applicable to the insolvent debtor’s claim.”[90] A set-off has been defined as a ”remedy employed by defendant to discharge or reduce plaintiff’s demand by an opposite one arising from transaction which is extrinsic to plaintiff’s cause of action.”[91] Therefore, if Global Bank would have outstanding obligations to Encore arising under any prior contractual relationship, Global Bank could set-off its claim under the standby letter of credit against the obligation previously incurred. The “law applicable to the insolvent debtor’s claim” means that in the main and secondary proceedings the law of each Member State in which such proceedings are opened constitutes the applicable law. Therefore, in the present hypothetical French set-off rules would be applicable in the main proceeding. Article 33(1) of the 1985 Law provides that even though the judgment initiating the insolvency proceeding prohibits any payment by the debtor to the benefit of creditors, the off-set of closely connected debts (creances connexes) remains possible.[92] The notion of “closely connected debts” has been liberally interpreted by French courts to include debts arising from the same contract, debts deriving from global purchase or sale agreements, or debts registered in the same bank account.[93] The availability of a set-off under the applicable national insolvency law is important where the assets of the debtor are insufficient to satisfy all the creditors’ claims. The strategic importance of a set-off reiterates the importance of the determination of where the debtor has its centre of main interest, especially considering the differences of national insolvency laws regarding set-off.[94] If the contract provided for the availability of set-off, then the applicable law governing the set-off is the law applicable to the contractual obligations, in the present hypothetical the place where the letter of credit transaction occurred.[95]

A major exception to the general provisions regarding the applicable law in insolvency proceedings can be found in the context of creditors’ or third parties’ rights in rem with respect to tangible or intangible assets of the debtor. The opening of insolvency proceedings will not affect rights in rem with respect to assets belonging to the debtor which are situated within the territory of another Member State at the time of the opening of the proceeding.[96] The applicable law to rights in rem is the law of the jurisdiction where the assets subject to the right in rem are located.[97] In other words, even if the liquidator of the main or a secondary proceeding has possession of the asset, the liquidator cannot make any decision regarding the asset which might affect the right in rem without the consent of the holder of the security interest in the particular asset.[98] Therefore, under the present hypothetical, the realization of Global Bank’s security interest in Encore’s inventory located in England would be governed by British and not by French law.

However, the liquidator of the main proceeding could potentially reach assets which are the subjects of rights in rem. If the insolvent debtor has an establishment in the Member State where these assets are located, the liquidator of the main proceeding can demand the opening of a secondary insolvency proceeding there; the realization of the assets, including those subject to rights in rem, will be conducted under the lex situs.[99] Insofar as the existing security right will not be affected, the liquidator of the main proceeding may, under the EC Regulation, be entitled to claim the excess value of the asset for the estate.[100] Furthermore, the liquidator may seize an asset serving as a security right in rem as long as no secondary insolvency proceedings have been opened in the Member State where the asset is located and if the value of the asset is higher than the claim for which the asset serves as security.[101]

If Global Bank decides to participate in multiple insolvency proceedings, Article 20 of the EC Regulation, the so-called “hotchpot” rule,[102] becomes applicable. In order to ensure the equal treatment of creditors in the main and secondary proceedings a creditor who has, in the course of an insolvency proceeding, obtained a dividend on its claim may share in distributions made in other proceedings only where the creditors of the same ranking or category have, in those other proceedings, obtained an equivalent dividend.[103] However, participating in all proceedings may nevertheless increase Global Bank’s prospects to find its claim satisfied to a larger extent, for the number of proceedings in which they participate will further the likelihood of obtaining a significant dividend in at least one of them.[104]

As already mentioned earlier in this Note, the EC Regulation does not apply to Encore’s assets located in the United States. Therefore, the treatment of the assets located in the United States has to be analyzed under the applicable provisions in the U.S. Bankruptcy Code as well as rules developed by courts in dealing with cross-border insolvencies. U.S. bankruptcy laws and judicial decisions provide for three possible procedures to resolve cross-border insolvencies. First, foreign representatives[105] can file a request for ancillary[106] proceedings under the U.S. Bankruptcy Code.[107] Second, U.S. bankruptcy courts can defer jurisdiction over the insolvency proceedings to foreign courts based on the principle of comity.[108] Finally, the U.S. and foreign courts can establish protocols of cooperation, which set forth the applicable law governing certain aspects of cross-border insolvencies.[109]

The main reason to provide for ancillary or foreign proceedings in the United States is to prevent the dismantling of the foreign estate by American creditors.[110] After the opening of the ancillary proceeding, there is no automatic stay of creditor collection activities.[111] However, the competent U.S. court may issue an injunction with the same effects as a stay order.[112] Besides injunctive relief, the U.S. court may also order the turnover of property of the foreign estate located in the United States to the foreign representative.[113] The turnover of property depends upon the ability of the court in the foreign proceeding to administer these assets, which will be determined by the laws of the country conducting the main proceeding.[114] The judgments of the ancillary proceeding only affect assets located within the United States.[115]

In the United States, sufficient case law indicates that American courts will extend comity under traditional doctrines of conflict of laws if the foreign jurisdiction’s insolvency laws are similar to those in the U.S. Bankruptcy Code.[116] A recent decision by the Ninth Circuit Court of Appeals suggests that U.S. courts may recognize a foreign judgment if the debtors did not allege that the foreign proceedings failed to meet the requirements under Section 98 of the Restatement of Conflict of Laws.[117] Among these requirements are the opportunity for a full and fair trial, a court competent of jurisdiction, regular proceedings, due citation or voluntary appearance of the defendant, and lack of bias, prejudice, or fraud.[118] In Society of Lloyd’s v. Ashenden,[119] the Seventh Circuit Court of Appeals applied the “compatibility” standard in order to determine whether a judgment by an English court could be enforced. The main reason for the court in Ashenden to recognize the English judgment was the fact that the English system is compatible with the requirements of due process. While the theoretical compatibility of the legal systems in the United States and foreign jurisdictions will make it likely that U.S. courts will recognize and enforce judgments of courts in those foreign jurisdictions, the U.S. courts will take the totality of the circumstances of the foreign system into consideration.[120] A U.S. court will not, for example, enforce a foreign judgment issued by a court that uses identical proceedings on paper if political instability will make it likely that these procedural safeguards of fairness will not be observed.[121]

In the absence of a formal treaty, practitioners and courts have created what are essentially case-specific, private international insolvency treaties. These mechanisms for coordinating multinational proceedings have come to be known as cross-Border insolvency cooperation protocols, or more simply, protocols. The main purpose of protocols is to set forth procedural and substantive elements of law according to which a cross-border insolvency should be governed.[122] Protocols are particularly necessary if two main proceedings are conducted concurrently in two jurisdictions which affect the same parties.[123]Furthermore, cooperation protocols provide for more efficient insolvency proceedings because from the outset, possible sources for dispute must be negotiated. Moreover, the use of cooperation protocols eliminates overlapping proceedings.[124] Protocols can focus either on the cooperation between the foreign administrators, or they can pertain directly to the communications between the foreign courts.[125] While protocols of cooperation in cross-border insolvencies are more likely to be used if the countries involved share the same legal system,[126] protocols have been used between courts of common law and civil jurisdictions.[127] Especially where deferral of jurisdiction over an insolvency is impossible, the drafting of a cooperation protocol has been proven to guarantee fair and equal treatment of foreign creditors.[128]

A cross-border insolvency protocol was for the first time effectively used during the reorganization of the insolvent Maxwell Communication Corporation PLC (MCC). MCC was an English holding company headquartered in London with more than 400 subsidiaries worldwide.[129] Most of MCC’s assets were located in the United States. After suffering financial difficulties, MCC filed petitions with courts in both London and New York for protection from creditors. The almost simultaneous filing of both petitions made the MCC cross-border insolvency more complicated because it was impossible to discern whether England or the United States should have jurisdiction over the main insolvency proceeding. To make matters worse, the differences in the national insolvency laws regarding the administration of the estate were significant because English insolvency law provided for the immediate appointment of an independent administrator who would take control over all assets of MCC, whereas the United States Bankruptcy Code allowed a debtor-in-possession management.[130] However, before an actual conflict could arise, the examiner appointed in the Chapter 11 proceeding and the British administrator agreed to coordinate the two insolvency proceedings through the use of a cross-border insolvency cooperation protocol. The protocol, which was subsequently approved by the U.S. Bankruptcy Court and the London High Court, provided that the British administrators have to make good faith efforts to consult with the U.S.-appointed examiner and to obtain his consent before taking significant steps during the insolvency proceeding.[131] Eventually, the United States Bankruptcy Court approved the reorganization plan and the London High Court a similar scheme of arrangement.[132]

Despite the recent successes of cross-border insolvency protocols, it must be noted that the range of application of these protocols is limited. Except for the handful of occasions in which a protocol has been drafted between a common-law jurisdiction and a civil-law jurisdiction, protocols have primarily involved Canadian, English and other common law jurisdictions.[133] A protocol between a civil-law jurisdiction and a common-law jurisdiction seems only feasible where the cross-border insolvency involves a simple liquidation procedure instead of a reorganization plan or where the national insolvency laws are substantially similar.[134] Furthermore, while protocols typically involve courts in two, at the most three jurisdictions, multinational entities usually have offices and assets in a significant number of countries. Thus, the drafting of a cross-border insolvency protocol for multiple insolvency proceedings involving many jurisdictions might prove to be an insurmountable task.

IV. CHOICE OF LAW AND THE CLAIMS OF BENEFICIARIES OF A STANDY LETTER OF CREDIT AGAINST AN INSOLVENT ISSUING BANK

If the issuer of a letter of credit becomes insolvent, the credit beneficiary faces the problem it seeks to avoid because it has a claim against an insolvent entity and, unless the credit is collateralized or there is a deposit earmarked for the credit transaction, the beneficiary will be only a general creditor of the insolvent issuer.[135] As already mentioned earlier in this Note, the EC Regulation, which constitutes the most comprehensive international insolvency legislation regarding conflicts of laws and norms for cooperation between competent authorities to date, is not applicable to credit institutions. The UNCITRAL Model Law and most of the bilateral and regional agreements regarding cross-border insolvencies similarly exclude banks from their application.

In the absence of an international framework dealing with the winding-up or the reorganization of financial institutions, the coordination of multiple insolvency proceedings is dependent upon the respective national laws of each country exercising jurisdiction over the insolvent banks or one of its branches.[136] In multinational bank defaults, insolvency proceedings could be opened in jurisdictions where the bank maintains local branches or where the bank possesses assets. Conflicts will necessarily arise where multiple insolvency proceedings determine the distribution of the debtor’s assets. The resolution of these conflicts will largely depend upon the interaction of the insolvency or banking laws of the various jurisdictions involved.[137] Since the provisions regarding the treatment of insolvent banks vary significantly among jurisdictions and bank insolvency is still recognized to be in the purview of competence of the respective national authorities, the probability that these authorities cooperate with a foreign court and comply with its orders is very slim.

The hypothetical described in Part III, changed slightly, shall once again serve as an illustration for the discussion in this section: On July 9, 2002, the German steel company Metallwaren AG enters into a contract with the French car manufacturer Encore which provides for the sale of hot-rolled steel. Subsequent to the execution of the contract, Encore requested the local branch of Global Bank in Nice to issue a standby letter of credit with the German company as beneficiary. After Encore provided the Global Bank with a security interest in its inventory sufficient to cover the letter of credit, the bank issues the letter of credit to the German company on July 15, 2002. Metallwaren AG delivered the steel timely on August 21, 2002. Encore defaulted on its payments as required by the contract on September 18, 2002. Metallwaren AG granted Encore seven days in which to cure the default, but to no avail. On October 7, 2002, Encore declared that it is unable to pay its debts (cessation des paiements). On October 10, Metallwaren AG demanded that Global Bank honor the standby letter of credit. However, Metallwaren AG received notice that Global Bank was declared insolvent on September 22, 2002 and that liquidation proceedings have been commenced in the London High Court. Global Bank is incorporated in England, is headquartered in London, and has local branches in France, Germany, Italy and the United States. Furthermore, Global Bank has a bond deposit at the Austrian bank Handelsbank. The standby letter of credit was issued in Nice and the contract between Metallwaren AG and Encore was signed in Modena, Italy.

Cross-border insolvencies of multinational financial institutions are more complex than the default of corporations and bring to light the diversity of approaches taken by different jurisdictions. Before a large- or medium sized bank will be determined to be insolvent, governments will in most cases come to the rescue of these financially distressed bank in order to avoid negative consequences for the capital markets business.[138] Such regulatory “pre-insolvency” intervention is designed to address financial weaknesses and violations of prudential requirements at an early stage. Most countries in their banking laws provide for a bank supervisor who is empowered to take remedial action and direct a bank’s future business undertakings.[139] However, although their national banking laws contain special requirements limiting or even removing the ability of creditors to file insolvency petitions,[140] most of the Member States of the EU do not have comprehensive provisions on bank insolvency and consider it sufficient to apply general bankruptcy laws.[141] Only Italy has special administrative insolvency proceedings applicable to special entities, including banks.[142] Other jurisdictions, such as the United States, explicitly exclude financial institutions from the application of the general bankruptcy laws and have an entirely separate insolvency regime.

Of crucial importance to both the insolvent banks and its creditors is the determination of whether a jurisdiction takes a single-entity or separate-entity approach regarding a branch of the insolvent bank located in its jurisdiction. Countries with the separate-entity approach, such as the United States[143] and France,[144] seize the assets of a local branch of an insolvent bank and distribute them among creditors with claims against that branch.[145] Under this doctrine each branch of a foreign bank operating in the jurisdiction is treated as a separately incorporated legal entity for some purposes. In the event of a liquidation of a foreign bank with a local branch, the branch would be liquidated separately from the entity as a whole.[146] Creditors of the local branch would be reimbursed from the assets of that branch and other assets of the bank in the jurisdiction.[147] The local liquidator is empowered to distribute not only the assets of the branch worldwide but all the assets of the bank in the jurisdiction. Creditors of other branches are prohibited from participating in the local liquidation proceedings.[148] The assets would be administered first for the benefit of the creditors of the local branch and, in the unlikely case that a surplus exists upon the satisfaction of all claims, the liquidator may transfer any excess assets to another jurisdiction for distribution in an insolvency proceeding there.[149] The separate-entity approach has therefore potentially dire consequences for foreign creditors who do not have a direct claim against the local branch, because local creditors in the separate-entity jurisdiction may receive a higher share of their claim during the liquidation proceeding as compared to foreign creditors located in jurisdictions with a single-entity approach.[150]

Conversely, under the single-entity approach, which is followed by Great Britain and most other Member States of the EU, banks are liquidated as one legal entity and branches of foreign banks are being considered offices of the larger corporate entity.[151] All creditors of the bank, foreign or domestic, are entitled to prove in the liquidation. Claims of creditors of a particular branch would generally not obtain priority over the claims of creditors of other branches in the liquidation. Theoretically, liquidators in single-entity jurisdictions are concerned with the collection and administration of worldwide assets of the bank in liquidation. However, in practice, they are likely to obtain control only of assets located within their jurisdiction and foreign assets that are located in jurisdiction where they can obtain recognition.[152] For example, jurisdictions following the separate-entity approach are unlikely to cooperate with the foreign administrator of such a universal proceeding and turn over assets of the local branch, except in the case where a bilateral treaty between the two jurisdictions or national insolvency laws would mandate such cooperation.

The adoption by the competent national authorities of the exclusive right to administer the insolvency proceedings of a bank located in its jurisdiction leads inevitably to the creation of more than one set of proceedings, especially where assets, establishments and obligations of the insolvent bank are identified with more than one proceeding.[153] Although very few territorial proceedings today explicitly prohibit participation by foreign creditors, participation by foreign creditors in foreign proceedings depends on the availability of knowledge and information, their ability to be diligent and to overcome procedural obstacles.[154] The costs of collecting debts across international boundaries and the uncertainty of litigation are also factors making effective access to the debtor’s insolvency proceedings more difficult for the creditors.[155] Few creditors will have the resources to take advantage of multiple proceedings and prove outstanding debts in different countries, and then usually only because those creditors are themselves multinational entities.[156]

In the present hypothetical, Global Bank and its local branches could be subjected to territorial insolvency proceedings in England, Italy, Germany, the United States, and Austria. The different national approaches of these jurisdictions in dealing with insolvent banks has direct implications on where Metallwaren AG will be able to participate in or initiate an insolvency proceeding against Global Bank. Since Metallwaren AG’s claims arose from its transaction with Global Bank’s local branch in France, it cannot participate in U.S. liquidation proceedings because the United States uses the separate entity. This inability to participate in the U.S. proceeding could create a particularly adverse situation for Metallwaren AG if most of Global Bank’s assets are located there. Metallwaren AG could submit its claim to the U.S. court only if the letter of transaction would have occurred in the United States and it therefore would have become a direct creditor of the U.S. branch of Global Bank.

Theoretically, the best choice for Metallwaren AG to participate in the liquidation proceeding is in England because the court there will wind up Global Bank by using the single-entity approach. Accordingly, the English court will administer all of Global Bank’s assets, wherever they are located and its orders and judgment have worldwide effect. However, the single-entity approach presupposes that other jurisdictions will automatically recognize the English judgment. Such an automatic recognition is unlikely to occur in jurisdictions which apply the separate-entity approach to branches of foreign banks. Similarly to the United States, France applies the separate-entity approach to local branches of insolvent foreign banks. The standby letter of credit was issued by Global Bank’s branch in Nice. Therefore, Metallwaren AG, as beneficiary of the letter of credit, became a direct creditor of the French branch and is be able to lodge its claim with the competent French court. Metallwaren AG could also file a petition to commence an insolvency proceeding in Italy.

Austrian private international law permits a foreign creditor to pursue its claim in an Austrian insolvency proceeding regardless of whether the jurisdiction in which the foreign creditor is located has entered into a bilateral or multilateral treaty with Austria.[157] It is nevertheless important to mention that Austria has concluded a bilateral treaty regarding cross-border insolvency matters with Germany.[158] Additionally, Metallwaren AG may pursue as foreign creditor its claim in an Austrian insolvency proceeding regardless of whether a bilateral or multilateral treaty exists between Austria and Germany exists. Finally, the most convenient forum-selection for an insolvency proceeding would be Germany, because Metallwaren AG has its place of incorporation there and would not have to litigate in a foreign jurisdiction. While Metallwaren AG has the standing to lodge claims in Italy, England, France, and Austria, its pursuit of litigation in the se jurisdictions is made more complicated by a lack of effective notice of proceedings and by difficulties due to language and legal barriers. Such procedural difficulties may lead to the complete loss of a claim against the insolvent bank.[159]

The most important stage for every creditor is the actual satisfaction of its claims against the debtor. However, in most instances the assets available in a single jurisdiction will not suffice to cover all claims completely and usually unsecured creditors find themselves undercompensated at the closure of an insolvency proceeding. Therefore, creditors will seek to enforce the judgment rendered by a domestic court in another jurisdiction without actually having to participate in a full insolvency proceeding there under local law. As can be expected in the absence of an international insolvency framework, the willingness of foreign jurisdictions to turn over assets located in its jurisdiction or to enforce a foreign judgment is highly uncertain. Unless the domestic insolvency laws contain specific provisions, trustees or similar administrators in insolvency proceedings are often unwilling to transfer domestic assets elsewhere in order to assist other operations involving the insolvent bank. Quite often, there may be no specific statutory authority for cooperation and any transactions which would could assist foreign insolvency proceedings elsewhere may run contrary to domestic public policy or law.

Since only multinational creditors can afford to incur the expenses of litigating in multiple fora, most creditors will seek to pursue their claim in a domestic insolvency proceeding and then petition, either by their own initiative or through a foreign representative, the foreign court to enforce the judgment rendered in the domestic proceeding. Until a comprehensive international insolvency agreement is adopted which provides guidelines regarding the recognition of foreign judgments in cross-border insolvencies, the private international rules of each jurisdiction will be outcome-determinative. It is pertinent for all creditors to be aware of these rules before they attempt to enforce a domestic judgment in another jurisdiction. This Note will in the following discuss the different treatment of cross-border insolvencies under the private international law provisions of France, Austria, Italy, Germany, and the United Kingdom.

France does not have a separate statutory framework that addresses cross-border insolvencies. Contrary to the United States, French case law suggests that French courts will predominantly apply the territoriality principle in cross-border insolvencies.[160] However, a foreign administrator or creditor seeking to enforce a foreign judgment may petition the Tribunal de Grande Instance to issue an order recognizing the foreign judgment (exequatur) and give this decision the same authority as a French judgment.[161] Article 2123 of the French Civil Code sets forth the factors that French courts consider in determining whether to permit a request for recognition of a foreign judgment: 1) French courts cannot have exclusive jurisdiction because of conflict of jurisdiction rules; 2) French courts must find the jurisdiction asserted by the applicant acceptable; 3) the choice of foreign court must no be fraudulent; 4) the foreign court must be competent to make the insolvency order; 5) the foreign judgment must not be fraudulent; and 6) the judgment must no contradict French public policy.[162]

The party seeking enforcement must have a direct interest in the enforcement of the foreign judgment.[163] Once the foreign administrator or creditor has obtained an order of enforcement, the foreign judgment may be executed in France.[164] Although the foreign bankruptcy proceeding is enforced by a French decision, it is subject to the foreign law.[165] If a foreign creditor fails to file a request for an exequatur, the foreign judgment will have no effect on the debtor’s assets located in France because France is not a party to multinational treaties.[166] Rather, France only has entered into bilateral international insolvency treaties with Belgium, Italy, Monaco, and Austria.[167] These bilateral treaties provide that the courts of each country where the debtor has a registered business will have jurisdiction over the insolvency proceedings. Moreover, the foreign courts’ judgments will be enforced in the other country party to the treaty.[168] Although the foreign creditor still needs to request an exequatur in France, the process is facilitated in the light of a bilateral treaty.[169]

The necessity of acquiring an exequatur in France raises the important question of whether only a final judgment can be enforced or whether other preliminary measures may be taken by the foreign court and be enforced in France.[170] The Cour de Cassation in Kleber held that foreign insolvency proceedings take effect not only from the moment an exequatur order has been issued in France but also from the date of the foreign bankruptcy order.[171] The holding by the French Supreme Court is very important in order to determine whether certain transfers constituted fraudulent or preferential transfers.

As a general rule, Austrian courts do not recognize any decisions issued by any foreign insolvency authorities, except where a multilateral convention or a bilateral treaty with such country exists.[172] Austria has concluded bilateral treaties in insolvency matters only with Belgium, Germany, France, Italy, and the United Kingdom.[173] Even if such a bilateral has been concluded between Austria and the foreign jurisdiction, several criteria must be met before a foreign judgment will be enforced by an Austrian court. The Austrian Enforcement requires that 1) the foreign authority must have had jurisdiction over the debtor to initiate bankruptcy proceedings; 2) there must have been proper service of the order initiating the proceeding; 3) the foreign order must be enforceable in the country of origin; and 4) no recognition and enforcement can be granted if the debtor has not been given due process of law of if the order violated public policy.[174]

Decree No. 218 of 31 May 1995 profoundly changed the area of the Italian private law system.[175] Article 64 of Law No. 218 provides for the automatic recognition of a foreign judgment in Italy if certain criteria are met.[176] First, the judgment must have been issued by a judge having jurisdiction on the case according to principles of Italian law; second, the writ initiating the proceedings was served upon the debtor in accordance with the lex concursus of the right of defense; third, the judgment is res judicata according to lex concursus; fourth, the judgment does not rule against another judgment issued by an Italian judge; fifth, no process, started before the foreign process and between the same parties, is pending before an Italian judge for the same matter; and sixth, the effects of the foreign judgment are not contrary to the Italian public order.[177] The last requirement that a foreign judgment must not violate Italian public policy is very important because it represents a significant restriction on the enforcement of a foreign insolvency judgment. An Italian court will not recognize and enforce a foreign judgment if the judicial authorities of the foreign jurisdiction violated its duty to sufficiently notify the debtor about the existence of insolvency proceeding and thus deprived the debtor of its right to be heard and defend itself.[178]

There are limits to how much effect foreign judgments will be given by German courts.[179] The most important factor that German courts consider is whether the foreign judgment substantially comports with German insolvency proceedings. The criteria used to determine compatibility include the purpose of the proceedings (equal satisfaction of creditors in a common manner), the procedures available to reach this aim (liquidation or reorganization), and the fact that some form of insolvency is required under the foreign insolvency law in order for the proceedings to be commenced.[180] German courts take particular notice of whether creditors will be satisfied equally and in an order similarly proscribed by German law.[181] If foreign court has granted the opening of an insolvency proceeding, such an order will generally be recognized by German court if the foreign court has jurisdiction over such a proceeding.[182] If an order issued by a foreign court granting a petition is recognized, it will be enforceable in the same way as a judgment rendered by a German court.[183] The specific legal effects of such an order, i.e. whether the trustee can avoid a transaction or preferential transfer, will be determined in accordance with the law of the foreign jurisdiction.[184]

When examining the incompatibility, German courts do not have to focus on the provisions of foreign insolvency in general, but must consider the potential results in the each particular case. A denial of recognition regarding a foreign judgment may either extend to the entire judgment and will therefore have no legal effect in Germany or only to some specific results of the judgment.[185] Article 102 of the German Introductory Law to the Insolvency Code provides that despite the existence and recognition of a foreign insolvency proceeding, German creditors can initiate a separate proceeding in Germany. The judgment rendered in such a separate insolvency would only extend to the debtor’s assets located in Germany.[186] Although the Introductory Law does not specifically address the issue, the separate German proceeding would supersede a foreign proceeding regarding the debtor’s assets in Germany.[187] However, a separate German insolvency proceeding does not preclude the German administrator and the German courts from cooperating with foreign authorities.[188] Furthermore, even if a foreign proceeding has been initiated, a foreign representative cannot commence an insolvency proceeding in Germany. Rather, only a foreign or German creditor can commence such a proceeding.[189]

Similar to France, British statutory law does not specifically address the issue of cross-border insolvency. British courts generally adhere to the principle of cooperation and provide foreign creditors with access to the debtor’s assets located in England and Wales. Furthermore, British courts recognize judgments by foreign courts.[190] For example, a British court will generally enforce orders by foreign bankruptcy courts against an insolvent entity if the foreign court sits in the entity’s country of registration.[191] However, the debtor’s assets located in England or Wales will not automatically be turned over to the foreign representative.[192] Instead, the foreign administrator must file a petition for an order empowering him to seize and realize the debtor’s assets located in England or Wales. Such a petition will only be granted if the court determines that such an order would not adversely affect local creditors.[193]

The existence of a foreign insolvency proceeding does not bar a British court or creditor from initiating a separate proceeding. British courts have discretion to decide whether it is in the best interest of justice to allow an ancillary proceeding.